Set-Tops with DVD: Not in98

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It's an unlikely pairing: Digital set-tops for the
electronic delivery of movies, and DVD, the digital home-video packaged-media format.

Despite the obvious competition between both platforms, a
small but growing number of hardware manufacturers are exploring the potential market for
next-generation digital boxes incorporating DVD (digital versatile disc) drives.

Most of the impetus appears to be coming from the vendor
side, but at least one major MSO also seems to be interested. Tele-Communications Inc.
chairman and CEO John Malone spoke at length during several interviews in December about
the value of bundling set-top and consumer-electronics gadgetry, like DVD players,
together as part of the OpenCable platform.

'When I think about what other water this kind of
platform could carry, for instance, you could have a version with a DVD-playback device --
the cost is not that large,' Malone said. 'That could be a powerful thing for a
consumer-electronics company.

'Some potential manufacturers said they believe that some video-service providers are
interested in a hybrid home-video player/set-top. Adding a DVD drive, they said, will make
it easier to sell, rather than lease, digital boxes to consumers if they begin to move to
retail distribution by late 1998 or 1999.

There are clear technical advantages to building a DVD drive into a digital set-top,
manufacturers said. Each can share the same MPEG-2 decoder chip set, as well as
multichannel audio and graphics processors for on-screen displays and other functions in
digital set-tops. And links are being forged between packaged media on optical disc and
content delivered electronically.

As cable operators add transactional and other interactive applications, it is likely that
some service companies will distribute catalogs and other information that changes only
periodically on DVDs and use an electronic connection for ordering and information
updates.Tele-TV's original request for proposals for its planned 'Unity'
next-generation digital set-top box included a DVD drive as an option. Bell Atlantic
Corp., which has been negotiating with several potential vendors for a box similar to
Unity, is said by potential hardware suppliers to still be considering that configuration,
despite the fall of the telco consortium.It is no coincidence that the Unity RFP attracted
many of the same consumer-electronics companies --Panasonic Corp.,
Mitsubishi Corp. and Thomson Consumer Electronics Inc. -- that have been trying to break
into the digital set-top business.

All have been effectively shut out of the traditional cable
market, and all are more likely than traditional cable vendors to take a shot at new
hardware configurations, as well as new service-operator relationships. Those vendors are
also actively trying to build a DVD-player business at the same time.In that respect,
Digital Video Systems Inc. is one well-outfitted candidate to develop a hybrid box. The
Silicon Valley company, with facilities in China and suburban Atlanta, plans to introduce
its first DVD player in the United States early next year, and it is also looking for
opportunities in the digital-box business, 'on our own, or in partnership with a
digital set-top box manufacturer,' said Gary Franza, president of DVS' new-media
division, based outside of Atlanta.

DVS has held 'casual conversations' with Hyundai
Electronics America -- which owns just over 20 percent of DVS -- as well as with several
Japanese manufacturers looking at set-top opportunities in mainland China.'We've
also talked with Compaq [Computer Corp.] about the ultimate multifunction solution for the
living room,' Franza added. 'They've never decided on what that is.'

But one option would be a personal computer/TV
configuration that would also include the guts of a digital box.'The impetus for this
certainly comes from the consumer [electronics] houses,' said Jim Reinhart, an
engineer with Motorola Inc.'s semiconductor-products sector, who has been working on
digital set-top design. 'There's active development, [and] the push starts by
the second half of next year.'Reinhart conceded that cable operators have little to
gain from the hybrid box over the next year, and they probably won't begin to
consider it until they need a way to encourage consumers to buy set-top boxes.

'It's not clear that [consumer-electronics]
manufacturers will be let into the existing cable infrastructure,' Reinhart added.

In that case, he said, they can go after direct-broadcast
satellite companies or telcos.

Thomson -- a likely candidate to build a hybrid box -- has
talked in general terms about introducing a combination Digital Satellite System
receiver/DVD player at some point. But Thomson executives have downplayed that idea in
recent months.The downside to a hybrid DVD/digital box is the danger that by encouraging
consumers to own a DVD player, cable operators will undermine their own attempts to build
up revenues from video-on-demand and near-VOD. While that would not directly affect
DSS-receiver manufacturers selling hardware at retail -- their revenue from programming
subscriptions does not include pay-per-view transactions -- virtually every other digital
set-top is distributed by the same companies that provide programming.'To me,
[marrying a digital set-top box and DVD player] is not an obvious combination,' said
Bill Leuhrs, president of Zenith Electronics Corp.'s Zenith Network Systems unit.
Building in a digital VCR or digital disc recorder, though, 'might make sense,'
he added.

Franza said DVS has talked with a few system operators
about a hybrid box, including either a DVD drive or DVD recorder, although he declined to
name any of them. But, he insisted, 'the operators are interested in it as a consumer
product sold through retail distribution. There's clearly a significant interest
among the majority of cable operators in integrating more services in that box.'A
set-top with a DVD recorder 'might be more interesting. You'd have the option to
record and own [the program], where you pay some fee for recording that material,'
Franza said.That also raises the thorny issue of digital copy protection. Proposed federal
legislation on copy-protection policy remains stalled in Congress.

Given the continuing standards battles over a recordable
form of DVD, Leuhrs and other hardware executives said a set-top box with a recordable DVD
drive is probably several years off, at least.

But more than one hardware vendor said privately that this
is the logical long-term solution. Tape-based recording may be the only practical option
for now, but there is widespread belief that once set-tops with built-in recording
capabilities go mainstream, they will be based on optical media, rather than tape media.